Suppose NeuroConnect, a fictitious company, requested a loan of $300,000 from October, a real financial technology (fintech) lending platform. The loan would be doled out over the course of 36 months to finance the acquisition of lab equipment like an electron microscope and an MRI scanner. October uses an automatic loan assessment tool to attribute NeuroConnect a credit score of B on a scale of A+ to C- based on the company’s financial history, default probability, and projected profit margin. The annual interest rate, or an investor’s profit gain, is estimated at 6.3 per cent. Now, suppose you want to invest a portion of your savings to make some money. If you were in October’s position, would you consider NeuroConnect worth the risk?
The scenario above is an example of how fintech platforms, also known as peer-to-peer (P2P) lending businesses, attract multiple individual investors who are willing to invest funds in a given firm. This unconventional way of lending is financing small and medium-sized enterprises (SMEs) that banks are often unable to assist due to strict requirements on lending, such as evidence of valuable assets and a well-established business credit profile that these new companies often cannot fulfill.
Although banks dominate the global lending market, the innovative P2P business model facilitates the financing of SMEs, which has been a traditionally difficult task for banks to accomplish. In an interview with The McGill Tribune, Paul Beaumont, an associate professor at McGill’s Desautels Faculty of Management, discussed fintech’s potential to provide greater access to long-term funding and its unique limitations compared to the customary bank lending model.
“We’ve been lending the same way […] for decades,” Beaumont said. “I think it’s good to have this emergence of new actors in the small business lending markets—actors that are less regulated because [these lending firms] expand the set of products [that other innovative] firms [can now] have access to.”
Compared to banks, which are heavily regulated because they manage the money of millions of clients, fintechs are mainly regulated because of the risk they present for fraud.
On average, bank interest rates are three per cent lower than those of fintech loans. This significant difference is one of the major challenges fintechs face as they not only have to attract lenders, but also firms that are willing to borrow money at a higher interest rate. Despite this potential roadblock, automation based on artificial intelligence and faster delivery of loan application decisions are selling points that give fintechs a competitive edge over banks.
In spite of these advantages, fintech is not the primary player in the small business lending market. Beaumont says that the use of algorithms to predict whether a company is worth betting on and its probability of defaulting does not absolve fintech lending from the inherent risk associated with the practice. After all, the fintech market is still very small.
Beaumont emphasized the importance of small business lending because of SMEs’ vital contributions to both economic and community development. For instance, in 2021, small business employees accounted for a whopping 63.8 per cent of the total Canadian labour force according to Statistics Canada. Medium-sized business employees make up for another 21.1 per cent, while large businesses represent the remaining 15.1 per cent.
Canadian small businesses, therefore, constitute a powerful economic driver that can continue to flourish by receiving funding for their ideas in a more sustainable and accessible fashion than before.
“Fintech platforms may perhaps not completely change the market, but [they] still bring […] innovation in a market that has not been super innovative,” Beaumont said.
